Tesco, and the pressures of a price war

There must have been a siege mentality at Tesco recently, as they are locked in hand-to-hand battle with Asda and Sainsbury, and find that they are outflanked by Aldi and Lidl. Whether that justifies some of the tactics being employed to regain the upper hand, or the financial relationships they have had with suppliers for the last few years, is being investigated by the Serious Fraud Office, and is increasingly coming under public scrutiny. What could be the worst outcome for them: a serious fine which erodes their already-battered budgets, a change in accounting practices forced on them by the outcome of the SFO investigation, a real shift in the supplier/buyer power relationship that has so far seen Tesco, the buyer, with huge advantage, or a significant change in public trust and their relationship with their customers?

For as long as I can remember, there have been question marks about the way in which Tesco treat their suppliers. They have been investigated goodness knows how many times by the Office of Fair Trading (now Competition and Markets Authority), and there are many case studies and reports about the way in which they (and the other major supermarkets) exert pressure, particularly on agricultural suppliers. The power is in the hands of the supermarkets: according to an online report, Britain’s top ten supermarkets owe about £15billion to suppliers for goods at any one time, giving them leverage to 'negotiate' extra payments.

However, listening to The Report on Radio 4 last Thursday, I was really taken aback by the extent of those pressures, as they were explained by current and ex-suppliers and ex-staff of Tesco.

Much of Tesco's income comes, not from sales of goods and services to customers, but from payments they receive from suppliers. Some of those are called “rebates”, reported here in the FT: "Rebates are payments that Tesco receives from suppliers for hitting a certain level of sales, or for support for promotions. For example, Coca-Cola could offer a percentage discount on 2-litre bottles if 20m of them were sold in a specific period – but it will only pay this rebate if the sales target is hit. Tesco’s UK sales volumes have dropped as it loses market share to competitors, so there is a risk that such volume-driven rebate targets could be missed." The report in the FT is a fascinating one, very accessible to students, about the way in which such payments are pre-estimated by the retailers in order to be included in their accounts, and this practice has been largely responsible for the 'black hole' of £250mn in Tesco's accounts.

Rebates are clearly common in the industry, and a report in The Grocer implies that many suppliers see this as 'fair enough' - if Tesco can shift huge numbers of the goods, the suppliers and manufacturers benefit by selling more, producing at closer to full capacity and gaining economies of scale. However, there are other payments as well. There are listing or gate fees, in which the supplier pays tens or hundreds of thousands of pounds in order to get their products onto Tesco's shelves, more fees in order to get them displayed at eye level, and more recently, payments demanded in order to avoid having products delisted. The radio report carried several instances of small scale suppliers who simply couldn't make such payments, and so lost their contract to supply. As a sales negotiator quoted in The Grocer says, when a buyer says 'give me £4mn or I won't stock your product any more', things are getting desperate.

The figure which sticks most in my mind from radio 4's The Report is that one third of Tesco's gross profit comes, not from sales, but from payments made to them by suppliers. Surely, this cannot be a sustainable model for doing business; Tesco may be focusing on cutting costs to the bone in order to give low prices to customers - and also to retain market share. But suppliers have to make a fair profit, or they cannot stay in business. And if they go out of business, there are fewer goods for consumers to buy, less competition to allow us to benefit from better goods produced efficiently, and fewer jobs available to provide the income to pay for the grocery shopping.